A prolonged period of ultra-low interest rates poses the threat of a fresh financial crisis by encouraging excessive risk taking on global markets, the International Monetary Fund has said.
The Washington-based IMF said that more than half a decade in which official borrowing costs have been close to zero had encouraged speculation rather than the hoped-for pick up in investment.
In its half-yearly global financial stability report, it said the risks to stability no longer came from the traditional banks but from the so-called shadow banking system – institutions such as hedge funds, money market funds and investment banks that do not take deposits from the public.
José Viñals, the IMF’s financial counsellor, said: “Policymakers are facing a new global imbalance: not enough economic risk-taking in support of growth, but increasing excesses in financial risk-taking posing stability challenges.”
He added that traditional banks were safer after the injection of additional capital but not strong enough to support economic recovery.
Viñals said the IMF had analysed 300 large banks in advanced economies, making up the bulk of their banking system. It found that institutions representing almost 40% of total assets lacked the financial muscle to supply adequate credit in support of the recovery. In the eurozone, this proportion rose to about 70%.
“And risks are shifting to the shadow banking system in the form of rising market and liquidity risks,” Viñals said.
“If left unaddressed, these risks could compromise global financial stability.” The stability report said low interest rates were “critical” in supporting the economy because they encouraged consumers to spend, and businesses to hire and invest.
But it noted that loose monetary policies also prompted investment in high-yield but risky assets and for investors to take bigger bets. One concern is that much of the high-risk investment has taken place in emerging markets, leaving them vulnerable to rising US interest rates.
“Accommodative policies aimed at supporting the recovery and promoting economic risk taking have facilitated greater financial risk taking,” the IMF said. As evidence it pointed to rising asset prices, smaller premiums on riskier investments and the lack of volatility in financial markets.
In many cases, the IMF said the behaviour of investors was at odds with the state of the global economy.
“What is unusual about these developments is their synchronicity: they have occurred simultaneously across broad asset classes and across countries in a way that is unprecedented.”
The IMF said there was a trade-off between the upside economic benefits of low interest rates and the money creation process known as quantitative easing and the downside financial stability risks.
While its report found that in some countries, including the UK and the US, economic benefits were becoming more evident, it warned that “market and liquidity risks have increased to levels that could compromise financial stability if left unaddressed”.
It said developments in high-yielding corporate bonds were “worrisome”, that share prices in some western countries were high by historical norms, and that there were pockets of real estate over-valuation.
“The best way to safeguard financial stability and improve the balance between economic and financial risk taking is to put in place policies that enhance the transmission of monetary policy to the real economy – thus promoting economic risk taking – and address financial excesses through well-designed macroprudential measures.”
These include tougher supervision of banks, requirements on them to hold more capital, and curbs on lending to specific sectors such as housing. Viñals said it was time for traditional banks to overhaul their business models.
This would involve not only changing the focus of their lending, but also consolidation and retrenchment.
“In Europe, the comprehensive assessment of balance sheets by the European central bank provides a strong starting point for these much-needed changes in bank business models,” he said.
theguardian.com
The Washington-based IMF said that more than half a decade in which official borrowing costs have been close to zero had encouraged speculation rather than the hoped-for pick up in investment.
In its half-yearly global financial stability report, it said the risks to stability no longer came from the traditional banks but from the so-called shadow banking system – institutions such as hedge funds, money market funds and investment banks that do not take deposits from the public.
José Viñals, the IMF’s financial counsellor, said: “Policymakers are facing a new global imbalance: not enough economic risk-taking in support of growth, but increasing excesses in financial risk-taking posing stability challenges.”
He added that traditional banks were safer after the injection of additional capital but not strong enough to support economic recovery.
Viñals said the IMF had analysed 300 large banks in advanced economies, making up the bulk of their banking system. It found that institutions representing almost 40% of total assets lacked the financial muscle to supply adequate credit in support of the recovery. In the eurozone, this proportion rose to about 70%.
“And risks are shifting to the shadow banking system in the form of rising market and liquidity risks,” Viñals said.
“If left unaddressed, these risks could compromise global financial stability.” The stability report said low interest rates were “critical” in supporting the economy because they encouraged consumers to spend, and businesses to hire and invest.
But it noted that loose monetary policies also prompted investment in high-yield but risky assets and for investors to take bigger bets. One concern is that much of the high-risk investment has taken place in emerging markets, leaving them vulnerable to rising US interest rates.
“Accommodative policies aimed at supporting the recovery and promoting economic risk taking have facilitated greater financial risk taking,” the IMF said. As evidence it pointed to rising asset prices, smaller premiums on riskier investments and the lack of volatility in financial markets.
In many cases, the IMF said the behaviour of investors was at odds with the state of the global economy.
“What is unusual about these developments is their synchronicity: they have occurred simultaneously across broad asset classes and across countries in a way that is unprecedented.”
The IMF said there was a trade-off between the upside economic benefits of low interest rates and the money creation process known as quantitative easing and the downside financial stability risks.
While its report found that in some countries, including the UK and the US, economic benefits were becoming more evident, it warned that “market and liquidity risks have increased to levels that could compromise financial stability if left unaddressed”.
It said developments in high-yielding corporate bonds were “worrisome”, that share prices in some western countries were high by historical norms, and that there were pockets of real estate over-valuation.
“The best way to safeguard financial stability and improve the balance between economic and financial risk taking is to put in place policies that enhance the transmission of monetary policy to the real economy – thus promoting economic risk taking – and address financial excesses through well-designed macroprudential measures.”
These include tougher supervision of banks, requirements on them to hold more capital, and curbs on lending to specific sectors such as housing. Viñals said it was time for traditional banks to overhaul their business models.
This would involve not only changing the focus of their lending, but also consolidation and retrenchment.
“In Europe, the comprehensive assessment of balance sheets by the European central bank provides a strong starting point for these much-needed changes in bank business models,” he said.
theguardian.com
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